W1: Lecture 2

Question 1

Factors influencing the leading indicator strength

Answer 1

A moderator might influence the strength of the leading indicator.

Common moderator: competition (type and intensity).

<customer satisfaction —> financial performance?>
High customer satisfaction companies focus on the products and on customer experience.

It is not the same with service firms -> they don’t have a tangible product, so it is much harder to perfect the services with high competition and focusing on costs.

Question 2

Drivers for customer satisfaction

Answer 2

Reverse casualty: money —> cust. satisfaction
So, the leading indicator and financing loop create a vicious cycle.

Prior financial performance determines future spending:
Bad financial performance is met by costs in R&D.
Bad financial performance is met by cuts in advertising.

Question 3

The Walmart case takeaways

Answer 3

Reasons for revenue decline:
*After the 2008 crisis, the wealth level did not allow people to spend a lot of resources on extra products
*Different business models emerge (Amazon as an e-retailer)

What did they do?
–> improve employee motivation and thus customer experience.
–> improve employee training and pay increase

—> Take on some costs and losses in the short term to improve in the long term.
So non-financial indicators have a long-term effect, which might not show up short-term effect in the financials.

Question 4

Why is it hard to prove that CSR is leading indicator of financial performance?

Answer 4

1. Sampling bias
   Logical error of concentrating on observations that made it past the selection process and overlooking those that did not.
   <”Survivorship bias” with planes example>
2. Fuzzy concept
   Many different definitions of ESG concepts and their measurements. Operationalisation makes measurement difficult.
3. Reversed causality
   False belief that X causes Y, in reality Y causes X.
4. Endogeneity
   Situation where the relationship between X and Y is caused by unobserved Z.

Question 5

Sampling Bias relates to CSR as a leading indicator: issue…

Answer 5

Related to CSR:
Looking at the firms that do good in their CSR reporting, but those that do bad relative to CSR might not voluntarily report their CSR practices (before the mandate for everyone to report).
–> invalid results

Question 6

Reversed Causality relates to CSR as a leading indicator: issue…

Answer 6

Does CSR influence financial performance or the other way around?

Financially stable companies might be stable enough to increase CSR practices.

Question 7

Fuzzy Concepts relates to CSR as a leading indicator: issue…

Answer 7

No clear definition of ESG and CSR. Wide aspect of definitions –> for each company, it might be something else. We can’t compare so easily.

Solution: ESG ratings/scores.
But still an issue in how these ratings are calculated and constructed?
<also, agency issue if pay to evaluate the company>

CSRD directive: helps to calculate some score, and also what is important for a company to disclose. Easier to compare based on this directive.

Question 8

Endogeniety relates to CSR as a leading indicator: issue…

Answer 8

Omitted Variable Bias

Maybe both high CSR and good financial performance are caused by a third factor: great leadership or innovative culture.

If we don’t include this third factor in the model, we falsely assume that CSR is causing the financial performance.

Question 9

What does the Norway gender quota case teach us about the challenges of using diversity as a leading indicator of financial performance, and how does endogeneity play a role?

Answer 9

The Norway gender quota case, which mandated at least 40% female representation on corporate boards, showed no clear improvement in firm performance post-implementation. This challenges the idea that gender diversity is a universal leading indicator of financial performance.
Results of the quota being introduced:
–> negative market reaction
–>decrease in operating profits

The case highlights the role of endogeneity, such as:
*Reverse causality (e.g., firms with better performance might attract more diverse leadership),
*Omitted variables (e.g., firm culture or management quality driving both diversity and performance),
*And context dependency (i.e., whether board diversity matters depends on firm-specific or institutional settings).

Thus, even if diversity correlates with performance, proving a causal, predictive link is difficult due to these threats to causal inference.